Efficient Portfolio: Market Beta and Beyond

The rise of alternative beta investment strategies is a recent trend that positions itself at the fore of another powerful trend: the growth of passive “beta” investing. Passive investing in market indices began almost 40 years ago and received major support from financial theory, because of the influence of Sharpe–Lintner capital asset pricing model (CAPM) back in the 1960s. Both theory and empirical research have since accumulated evidence questioning the validity of the CAPM and the efficiency of the market portfolio.With the “one-for-all” market portfolio solution under attack, a family of new ideas on efficient equity investing—the alternative beta strategies—has been proposed to investors. This range of investment ideas is very heterogeneous, although its common denominator is the attempt to fix the inefficiencies discovered in cap-weighted portfolios. In this article, the authors review the reasoning behind the efficiency of the market portfolio, explore its flaws, and discuss the rationales behind the competing alternative beta investment approaches.